Capital Investments At Compass Group (LON:CPG) Point To A Promising Future

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at Compass Group's (LON:CPG) ROCE trend, we were very happy with what we saw.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Compass Group, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.20 = US$2.6b ÷ (US$22b - US$9.0b) (Based on the trailing twelve months to March 2024).

Thus, Compass Group has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Hospitality industry average of 7.9%.

See our latest analysis for Compass Group

Above you can see how the current ROCE for Compass Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Compass Group .

What Does the ROCE Trend For Compass Group Tell Us?

Compass Group deserves to be commended in regards to it's returns. The company has employed 33% more capital in the last five years, and the returns on that capital have remained stable at 20%. Now considering ROCE is an attractive 20%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If Compass Group can keep this up, we'd be very optimistic about its future.

On a side note, Compass Group's current liabilities are still rather high at 40% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. Therefore it's no surprise that shareholders have earned a respectable 50% return if they held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

If you want to continue researching Compass Group, you might be interested to know about the 1 warning sign that our analysis has discovered.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.